Eric M. Thorson, Inspector General U.S. Small Business Administration Before the Committee on Small Business and Entrepreneurship, United States Senate, July 12, 2006

Introduction.

Chair Snowe, Ranking Member Kerry, distinguished Members of the
Committee, thank you for inviting me to testify today about our activities and concerns regarding
the award of government contracts to small businesses.

The Small Business Act establishes a goal of awarding small businesses not less than
23 percent of the total value of prime contracts issued government-wide each fiscal year. The
Act further recognizes the Small Business Administration’s (SBA) advocacy role for small
businesses, and directs the SBA, in essence, to take all reasonable steps to promote opportunities
for small businesses, including firms owned by minorities, women, service disabled veterans,
and other disadvantaged persons, to obtain government contracts.

As you know, each year we issue a report on the major Management Challenges facing
SBA. One of the challenges refers to flaws in the procurement process that have allowed large
companies to receive and perform small business awards and agencies to receive small business
credit for contracts performed by large businesses.

My remarks today will focus on four issues concerning small business contracting:
(1) regulatory loopholes that allow agencies to count contracts as meeting their annual small
business goals even if companies have been acquired, or have grown large after being awarded
the contract; (2) large companies committing fraud to obtain small business contracts or using
small firms to hide the fact that a large business is actually performing the work; (3) contracting
personnel who may be unfamiliar with small business procurement requirements or who may not
exercise proper diligence to ensure that only legitimate small businesses obtain small business
contracts; and (4) inaccurate recording of contracts in the Federal Procurement Data System –
Next Generation (FPDS – NG) as awarded to small businesses when, in fact, they were awarded
to large businesses, and the large businesses did not make any representations that they were
small businesses. I will briefly discuss each of these issues in turn.

Regulatory Loopholes.

Regarding the first issue, there are several regulatory loopholes
that allow large companies to perform small business contracts. Studies by the OIG, the
Government Accountability Office (GAO), and SBA’s Office of Advocacy have found that
agencies are allowed to count towards their small business procurement goals contracts that are
performed by companies that have either been acquired by large firms, or have outgrown small
business size standards after obtaining the contract, but are exercising subsequent contract
options or task orders.

As noted above, the OIG has identified as a Management Challenge for the SBA the need
to take action to reduce regulatory loopholes that allow over-reporting of small business
procurements. We believe this is a very serious issue for the Federal Government for two
reasons: (1) legitimate small businesses lose out as agencies have little incentive to identify
other small business contracting opportunities; and (2) policy makers are deprived of accurate
information needed to assess the effectiveness of governmental policies.

Although the extent of such over-reporting is unknown, studies that we and the GAO
have conducted suggest that the problem may be widespread. In fact, one review we conducted
of SBA procurement (SBA Small Business Procurement Awards Are Not Always Going to Small
Businesses, Report No. 5-14) disclosed that four out of six large-dollar SBA contracts (procured
from 2000 to 2002) were awarded to companies that were no longer small. SBA reported these
contracts toward meeting its small business goals. Although this was allowed by regulation, the
fact that SBA is reporting contracts performed by large firms towards meeting its small business
goals makes it appear highly likely that other agencies, which have less interest in promoting the
interests of small companies, are doing the same thing.

Another problem relates to multiple award contracts where firms may not be small for all
of the goods or services covered by the contract. In other words, a contractor that only meets
small business criteria for a portion of a multiple award contract is considered to be a small
business for any work done under that contract. Thus, agencies may obtain small business credit
for using a firm classified as small even if the firm is not designated as small for all of the
procured goods or services. This is contrary to SBA regulations, which require that a contractor
meet the size standard for each product or service for which it submits an offer (13 C.F.R.
§ 121.407). An example of this problem was recently described in a June 14, 2006, GAO
briefing report entitled Commerce Information Technology Solutions Next Generation
Governmental Acquisition Contract.

Large Businesses Fraudulently Obtaining Small Business Contracts.

With respect to the
second issue – large businesses fraudulently obtaining small business contracts – the Small
Business Act provides for penalties of up to $500,000 and 10 years in prison for such fraud in
connection with an SBA small business contracting program. In the past 5 years we have opened
69 cases involving government contracting fraud and obtained 24 criminal fraud convictions,
resulting in fines, restitutions, and settlements of over $17 million. These cases have arisen
under the 8(a) Business Development Program and other SBA government contracting programs,
but we have yet to obtain a criminal prosecution of a large business that has misrepresented its
status as a small business in order to obtain a small business contract. Reasons for the difficulty
in obtaining such a conviction vary, but one problem certainly lies with the fact that, in the case
of small business contracting fraud, prosecutors are reluctant to accept cases where it is difficult
to show a financial loss to the U.S. Government. Unlike where a contractor has falsified
invoices, in many cases of small business contracting fraud the Government paid for and
obtained the particular good or service that it sought to procure. The fraud occurred in how they
acquired the contract, not in its execution. Nonetheless, there is a definite programmatic and
societal loss – a company that obtains a small business contract under false pretenses deprives a
contracting opportunity for a legitimate small business. In a recent case jointly investigated with
the General Services Administration (GSA) OIG, we obtained a $1 million settlement from a
company that made a false representation as a small business when receiving a GSA multi-year
contract. We believe this settlement sends an important message to the government contracting
community that false representations of size will have significant repercussions. It bears
mentioning, however, that the parent company denied any liability (as is customary in civil
settlements) and that the alleged misrepresentation was made by a subsidiary that had been
acquired after the misrepresentations had occurred.

Contracting Officer Error.

Our efforts to bring to prosecution cases of small business
contracting fraud have been complicated by the third issue that I want to focus on – contracting
officer error. Good cases have been undermined by contracting personnel at Federal agencies
who do not comply, or are just unfamiliar with small business contracting requirements. We
have seen errors where agencies accepted bids from contractors on small business contracts, even
though the contractors had not certified that they were small businesses. Other errors have
included failing to request size certifications from businesses, misuse of small business set-asides
to procure the products of large businesses (such as personal computers), relying on databases
containing inaccurate information about small businesses, misuse of the North American
Industrial Classification categories used to define small businesses, and failing to investigate
discrepancies that suggest that the contractor may not meet small business criteria. Although we
will continue to diligently investigate cases of contractor fraud, the reality is that juries are
reluctant to return guilty verdicts in a government contracting fraud case if the Government has
been negligent, or has failed to look into obvious discrepancies.

Incorrect Entries in FPDS-NG.

The fourth issue concerns incorrect entries in FPDS-NG
– the database used to develop and report government-wide statistics to Congress on small
business awards. While we have anecdotal evidence on this issue, we do not know the extent of
the problem. Over the past 3 years, we have received various complaints about large businesses
being reported in FPDS-NG as receiving small business awards. In some instances, this occurred
because the large business acquired a small business, or the business had been a small business
and grew large. The other common reason this occurred, however, was due to input errors. As
we followed up on these complaints, we found some awards where the procurement was
processed using “free and open” procedures and the award recipient had not represented that it
was a small business. Contracting offices have admitted that the small business designations
were simply input errors. Because FPDS-NG is the database for tracking government awards to
small business, it is important that the data is correct.

What can be done to correct the problems with small business contracting?

To its credit,
SBA has taken some steps in this area. SBA issued a proposed regulation in 2003 to require
contractors performing on multiple award contracts to annually recertify their small business
size. The OIG believes that an award recertification would provide a significant control over the
accuracy and integrity of small business contracting. In 2004, SBA issued final regulations
requiring that agencies obtain a recertification as to size when the contract is sold to another
company. However, it has now been more than 3 years since SBA issued its proposed rule on
annual certification. This rule needs to be finalized. Alternatively, Congress could amend
section 15(g) of the Small Business Act to require annual certification. Another positive step to
reduce contracting officer error would be to increase training on small business procurement for
contracting personnel. While maintaining that training is the responsibility of each procuring
agency, SBA stated that it has helped develop training modules and does provide training to
other agencies. Even if providing small business procurement training to contracting personnel
is not a direct SBA responsibility, we believe that as the advocate of small business, SBA needs
to provide whatever assistance it can in this area.
SBA has also submitted proposed legislation recommended by the OIG to revise section
16(d) of the Small Business Act, clarifying that SBA has the authority to debar a contractor for
size misrepresentation. In a recent case, the Agency was reluctant to proceed with debarment
because it was uncertain whether it had the necessary authority under section 16(d). Therefore,
this matter was referred to another agency for consideration. SBA officials suggest it is not
feasible for them to debar contractors who make size misrepresentations. While we agree that it
may be administratively easier in some cases for other agencies to process such debarments,
other agencies have little incentive to pursue the matter. We believe that, due to SBA’s unique
role as the agency primarily responsible for the set-aside programs, it should share in the
responsibility for policing these programs. We urge Congress to enact the legislation we have
suggested to make it clear that SBA can undertake a debarment for size misrepresentation.

Congress could also establish control processes within SBA. For instance, some SBA
officials have taken the position that, since the contracting agencies verify to GSA that the
information input into FPDS-NG is accurate, accuracy is an internal control issue for each
procuring agency – not SBA. However, legislation could create an office within SBA to monitor
contract integrity. That office could be responsible for determining whether procuring agencies
are complying with small business contracting requirements and whether the agencies are
accurately reporting on their negotiated small business contracting goals. Legislation could also
require the head of a procuring agency to certify as to the accuracy of the reported information,
and to conduct a review, through statistically valid sampling techniques or otherwise, to verify
that reported information correctly reflects small business contracting activity.

Conclusion.

To ensure that all opportunities are pursued to help small and disadvantaged
businesses obtain government contracts, we will continue to challenge SBA to improve
government-wide compliance with the goals of small business contracting; to aggressively
pursue prosecutions and debarments where warranted; and to seek creative and effective ways to
enhance the ability of small businesses to do business with the U.S. Government.

Thank you for the opportunity to comment. I look forward to answering any questions
that you may have.